How are my cryptocurrency gains taxed in the UK?

Cryptocurrency investors have had a rough time recently. From the spectre of higher taxes being proposed by US president Joe Biden to the “Elon Musk effect”, the market has given investors plenty of reasons to be happy and worry alike. So for some, their profits will be the last thing on their minds right now.

But plenty of crypto investors are still sitting on big gains. And anyone thinking of taking some of these profits really needs to be aware of the tax that they might incur when doing so.

So what are the rules in the UK?

HMRC does not treat cryptocurrencies like money

HMRC does not consider crypto assets to be money or currency. Instead, the tax office has grouped crypto assets into four main categories: exchange tokens, utility tokens, security tokens, and stablecoins.

“Exchange tokens” – which include cryptocurrencies such as bitcoin – are those tokens which derive their value from exchange or investment uses.

“Utility tokens” pave the way for crypto holders to buy services on a platform through distributed ledger technology. Long story short, they’re analogous to gift tokens.

“Security tokens” - which include the likes of non-fungible tokens (NFTs) – act as digital contracts for some type of valuable asset.

And “stablecoins” are crypto assets that are pegged to the value of fiat money or other assets (one example is Tether).

Anybody who resides in the UK and holds crypto assets will be taxed on any profits made on these assets.

“Individuals resident in the UK are taxed on their gains from cryptocurrencies in much the same way as those making gains on stocks and shares. Every time an individual swaps one coin for another, or indeed any other asset when purchasing goods, they are triggering a disposal for UK capital gains tax purposes,” points out Chris Etherington, private client tax partner at RSM UK.

To be clear, your “paper” gains are not taxed. Capital gains tax (CGT) is only due when a disposal has been made – and assuming there are any actual profits to tax.

How capital gains tax affects crypto investors

Your capital gain is simply the difference between what your cryptocurrency cost you, and how much you sold it for.

There is an annual CGT exemption, which currently stands at £12,300 for the 2021-2022 year. Gains up to this amount are not subject to CGT.

So what do you have to pay? “In broad terms, a UK resident making a capital gain made on the disposal of cryptocurrency is taxed at 10% up to the basic rate of tax (£37,700 to the degree the basic rate is not used) and 20% thereafter”, notes Nimesh Shah, chief executive of tax advisory firm Blick Rothenberg.

To calculate any tax due, you need to work out your profit, and then subtract the annual allowance. Then add any remaining profits to your taxable income for the year. If you are still below £37,500, then CGT will be charged at 10%. Above that, and it’s charged at 20%.

Calculating CGT can be tricky, partly due to the “30-day rule”. This rule was brought in some time ago to prevent people from using up their CGT allowance each year by selling shares then buying them back the next day. This enabled them to “rebase” the purchase price for CGT purposes and to use up their annual allowance where possible.

Now, however, individuals who sell shares have to wait 30 days before being able to reinvest in the same share, otherwise “matching” rules come into play which are designed to prevent this “re-setting” of the cost base. For assets like cryptocurrencies, which are often traded more aggressively than the average stock, this can make it tricky to work out exactly what your liabilities are.

Note too that cryptocurrency holdings are not immune from inheritance tax either, which may apply on worldwide assets or just UK assets depending on whether they are domiciled in the UK or not. “The value of any cryptocurrency held immediately before someone’s death will form part of their IHT,” Etherington says.

IHT liabilities can amount to 40% of an estate’s value although the thresholds and allowances are far higher than with CGT. (For a more detailed look at IHT, subscribe to MoneyWeek today –we have a free IHT report for new subscribers, plus you get your first six issues free).

Would I be taxed if I bought a Tesla using bitcoin?

Until last week, people could theoretically buy a Tesla using bitcoin. While Elon Musk very eloquently backtracked on that last week, that still doesn’t protect those who have already used a cryptocurrency to buy a Tesla or any other good alike from capital gains taxes.

“If an individual buys a Tesla for £50k in Bitcoin – but had only paid £40k for those Bitcoin, the act of buying the Tesla will trigger a capital gains tax charge on the £10k gain on the value of bitcoin,” says Leigh Sayliss, partner at law firm Howard Kennedy.

“It is only changes in the value of government-backed currencies and a very limited range of other limited assets (such as gold) that are excluded from capital gains tax.”

While CGT is the main tax facing crypto investors, activities such as cryptocurrency “mining” and “staking” both can potentially be subject to income tax. Mining is the process by which mathematical calculations are solved and new cryptocurrencies enter into circulation, while staking involves locking in cryptocurrencies to reap the rewards.

“Airdrops”, however, which involve businesses distributing small amounts of a coin to crypto wallets free of charge, often as part of a marketing campaign, won’t necessarily result in an income tax liability unless “something is done in return for receiving the coin”, Etherington says.

The main thing to be mindful of is that your crypto portfolio is just like your shares portfolio – if you make a profit, it will be liable for tax, and unlike your shares portfolio, you’re not going to be able to hold your crypto in a tax-efficient Isa. But being aware of this from the start means you can plan ahead to minimise any bills. And look on the bright side – paying capital gains tax means you made a capital gain in the first place.